Many of the distortions in poorlyperforming economies do not originate in the banking sector,but where state banks still control a large share of theresources in the banking system, they continue to pose arisk to macroeconomic and fiscal stability. State banks aretypically vehicles for patronage that worsen the prospectsfor competitive market development. Alternatively, thesestate banks can be ineffective shells that fail to perform auseful intermediation role once the government imposeseffective hard budget constraints and a modern supervisorysystem. The most problematic state banks have beenagricultural and industrial banks, whose original role wasto finance state farms and industrial enterprises thatemployed large numbers of people and served as the backboneof the socialist economic mode. Banks now show strongergrowth in deposits and capital in many countries in Centraland Eastern Europe and the Baltics, suggesting that thesecountries have put into place structures that have helped torestore confidence in banking systems among creditors,investors, and the public. Recommended strategies are thatGovernments need to design strategies to reduce statebanking in order to help create a stable bankingenvironment. Governments should take measures to improve thebusiness environment as part of a broad overall strategy tostrengthen the financial system and end state ownership ofbanks. Such measures include providing support to improvecorporate governance, reform judicial systems, buildregistries of collateral, reinforce creditors' rightsand contract enforcement, modernize accounting and auditingpractices, reduce administrative obstacles to businessregistration, and modernize bankruptcy laws.
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